Rebalancing risk and reward – March 2006

The Australian construction industry is suffering from low and declining profits; caused in large part by the misallocation of risk and a misunderstanding of the forces driving further efficiencies and productivity. Whilst the minor ‘pain’ of low profits is borne primarily by the contractors, many clients are finding it impossible to escape the consequences of major problems such as their D&C contractor becoming insolvent, intractable or intransigent. Many of these clients are finding themselves under resourced to manage these major problems when they arise. This paper identifies some of the structures and assumptions creating risk within construction projects and suggests a strategy to better align risk and reward.

Many clients select a ‘fixed price, D&C’ contract for their project based on the premise this is ‘low risk’; we argue in fact this approach may place all of the clients ‘eggs in the one basket’. The client surrenders, at least in part, control of the design of its building to a contractor who has a ‘horizon of interest’ extending one or two years into the future (not the 50 years the asset will be used). The contractor accepts an inherent conflict of interest between optimising the design for the client and minimising costs to keep the contract financially viable; and has access to tools such as the ‘Security of Payments’ legislation to help rectify cash flow problems if it finds itself losing money. The role of consultants in the design process is often marginalised and loyalties of novated consultants confused and dislocated.

The efficient management of risk requires contractors and clients to work together to deliver the right project for the right price. The legal/contractual framework to support this innovation requires careful sculpting for each project. It involves utilising modern forms of contract such as ‘partnering’ and ‘alliance contracts’, and needs the full spectrum of risks and requirements to be analysed and balanced in an effective and efficient way.

This paper will outlines the fundamental pre-conditions to the development of efficient risk balanced contracts that encourage effective relationships and efficient project delivery.